Decision Model (Normative)

Normative Decision Model
When beginning a home repair project, it is helpful to have all necessary tools close at hand. It is often advisable to even have extra tools within reach should the project be more complicated than originally thought. The larger the variety of tools in a handyman’s toolbox, the more likely he will be to fix the problems that he encounters.
In a way, a manager is like an organizational handyman. Managers identify and solve many types of problems (e.g., personnel, planning, scheduling, budgeting, technology, operations, facilities, policies, resources, etc.) with the best interests of their organizations in mind. Some problems are straightforward and predictable, and others are more complicated. A good manager, like a good handyman, is able to quickly determine the types of tools that he needs to fix the problems that he encounters.
Sometimes the tools that are needed to solve organizational problems are co-workers and the knowledge, insight, and creativity that they possess. People use the knowledge that they gain from past experiences to define and remedy the problems that they encounter. Knowledge can be gained from direct personal experiences or from the experiences of others. Groups are able to outperform individuals on mental tasks in large part because of the diversity of experiences that members bring to their groups. When the experiences of group members are used to solve problems instead of just those of a single manager, better solutions usually arise. The benefits of group problem solving, however, come with costs—primarily, the time spent by group members away from their normal work responsibilities.
Not all of the decisions that managers make need to be solved with the help of coworkers. Managers can make some decisions with little or no input from workers. Effective managers know when to solicit input from others and when to solve problems by themselves.  The Normative Decision Model, developed by Victor Vroom and his associates, gives explanation to the appropriate level of worker involvement in the decision-making process. Decision acceptance and decision quality drive the model. When it is important that workers buy into and accept the decision, they should be included in the decision-making process. Likewise, when it is important that exceptional and high-quality solutions be developed, more people should be included in the process. Time should also be considered when selecting the appropriate degree of worker involvement—as time available to make decisions decreases, more autocratic decision styles are appropriate. 
The model also describes five decision-making styles that range on a continuum from “autocratic” to “group.” The autocratic style is one where managers make decisions independently and autonomously. The middle dimensions involve the manager collecting relevant information from others, consulting with individual coworkers, and consulting with groups of workers before making decisions. Under the “group” style, managers allow their workers to solve problems. The appropriate decision-making style is dictated by characteristics of the situation—acceptance, quality, and time. Like tools, different decision-making styles are appropriate for different types of problems and skilled managers know when and how to use each of them.

Strategy and Information System

Strategy and Information Systems
Traditionally business organizations are divided into three levels. These are operational, management and strategic  levels. They exist in nearly all businesses irrespective of their size or sector of operations, although in small companies some levels may converge.
At the  operational level  decisions are made to ensure smooth running of operational processes or day-to-day business. At this level it is necessary to oversee that resources are used efficiently, inventory is up to date, production levels are as planned, etc. Decision making at this level requires information almost entirely internal to the company, although it may be extremely detailed and real-time.
Information for decision making at management level has a typical time-frame ranging from weeks to several month or a year. Middle management usually controls medium term scheduling, forecasting and budgeting operations. These rely on internal as well as occasional external information. For instance, setting the quarterly budget requires the knowledge of current expenditure as well as external pricing information.
Senior management will focus on general, or strategic , issues related to overall business development in the long term. At this level decisions tend to relate to issues with long term such as restructuring, major financial investments and other strategic undertakings related to company’s future rather than present. Information necessary for decision making at this level is comprehensively gathered not only from the internal sources of the company itself, but also involves external information, such as data related to economic situation or sectors as a whole.
Businesses that heavily rely on information develop an information strategy to establish how to manage information for business advantage and to comply with government regulations. An Information Strategy  is a planning document usually created at the strategic level by the Chief Information Officer (CIO), possibly together with a Chief Technology Officer (CTO) and IT manager. 
An information strategy is developed to support the overall business strategy of an organization and explains how information should be captured, processed, used and disposed of throughout its life cycle. Although the structure of an information strategy varies from business to business, there are some common areas included in most information strategy.
To provide specific guidelines to their employees, contractors, trading partners and other external stakeholder on the processing, storage and communication of various types of information, business firms usually create an  information policy  document. This document is extremely important when an organization handles security sensitive data or is subject to government guidelines related to information processing. It defines sensitivity levels of information and lists who has access to each level. The aim of the information policy is to make sure that information assets of a company are appropriately protected from threats.

Hoshin Kanri Planning Principles

 Hoshin planning is not a strategic planning tool in itself, but can be thought of as an execution tool for deploying an existing strategic plan throughout the organization, although it can facilitate the strategic planning process. It does depend on having a clear set of objectives articulated by the Chief Executive/Company President. Application of Hoshin Kanri will then translate the strategic intent into required day-to-day actions and behaviours. Hoshin planning principles are formulated around companies knowing what their customers will want in five to ten years, and understanding what needs to be done to meet and exceed all expectations. This requires a planning system that has integrated Deming’s “Plan-Do-Study-Act” language, and activity based on clear long-term thinking. The measurement system needs to be realistic, with a focus on process and results and identification of what’s important. Groups should be aligned with decisions taken by people who have the necessary information. Planning should be integrated with daily activity underpinned by good vertical and cross-functional communication. Finally, everyone in the organization should be involved with planning at local levels, to ensure a significant buy-in to the overall process. Figure 5.3 shows a model of the Hoshin planning system.

The major elements of the model can be summarised as:
•     Five-year vision :  This should include a draft plan by the president and executive group. This is normally an improvement plan based on internal and external obstacles, and revision based on input from all managers
on the draft plan. This enables top management to develop a revised vision that they know will produce the desired action.
•     The one-year plan:  This involves the selection of activities based on feasibility and likelihood of achieving desired results. Ideas are generated from the five-year vision, the environment and ideas based on last year’s performance. The tentative plans are rated against a selection of criteria and a decision made on the best action plans.
•     Deployment to departments: This includes the selection of optimum targets and means. It focuses on the
identification of key implementation items and a consideration of how they can systematically accomplish the
plan. The individual plans developed are evaluated using the criteria that were used for the one-year plans.
•     Detailed implementation:  This is the implementation of the deployment plans. The major focus is on contingency planning. The steps to accomplish the tasks are identified and arranged in order. Things that could go wrong at each stage are listed and appropriate countermeasures selected. The aim here is to achieve a level of self-diagnosis, self-correction and visual presentation of action.
•     Monthly diagnosis:  This is the analysis of things that helped or hindered progress and the activities to benefit from this learning. It focuses attention on the process rather than the target and the root cause rather than the symptoms. Management problems are identified and corrective actions are systematically developed and implemented.
•     President’s annual diagnosis: This is the review of progress to develop activities which will continue to help each manager function at their full potential. The president’s audit focuses on numerical targets, but the major focus is on the process that underlies the results. The job of the president is to make sure that management in each sector of the organization is capable. The annual audit provides that information in summary and in detail.

Hoshin Kanri Planning Principles

 Hoshin planning is not a strategic planning tool in itself, but can be thought of as an execution tool for deploying an existing strategic plan throughout the organization, although it can facilitate the strategic planning process. It does depend on having a clear set of objectives articulated by the Chief Executive/Company President. Application of Hoshin Kanri will then translate the strategic intent into required day-to-day actions and behaviours. Hoshin planning principles are formulated around companies knowing what their customers will want in five to ten years, and understanding what needs to be done to meet and exceed all expectations. This requires a planning system that has integrated Deming’s “Plan-Do-Study-Act” language, and activity based on clear long-term thinking. The measurement system needs to be realistic, with a focus on process and results and identification of what’s important. Groups should be aligned with decisions taken by people who have the necessary information. Planning should be integrated with daily activity underpinned by good vertical and cross-functional communication. Finally, everyone in the organization should be involved with planning at local levels, to ensure a significant buy-in to the overall process. Figure 5.3 shows a model of the Hoshin planning system.

The major elements of the model can be summarised as:
•     Five-year vision :  This should include a draft plan by the president and executive group. This is normally an improvement plan based on internal and external obstacles, and revision based on input from all managers
on the draft plan. This enables top management to develop a revised vision that they know will produce the desired action.
•     The one-year plan:  This involves the selection of activities based on feasibility and likelihood of achieving desired results. Ideas are generated from the five-year vision, the environment and ideas based on last year’s performance. The tentative plans are rated against a selection of criteria and a decision made on the best action plans.
•     Deployment to departments: This includes the selection of optimum targets and means. It focuses on the
identification of key implementation items and a consideration of how they can systematically accomplish the
plan. The individual plans developed are evaluated using the criteria that were used for the one-year plans.
•     Detailed implementation:  This is the implementation of the deployment plans. The major focus is on contingency planning. The steps to accomplish the tasks are identified and arranged in order. Things that could go wrong at each stage are listed and appropriate countermeasures selected. The aim here is to achieve a level of self-diagnosis, self-correction and visual presentation of action.
•     Monthly diagnosis:  This is the analysis of things that helped or hindered progress and the activities to benefit from this learning. It focuses attention on the process rather than the target and the root cause rather than the symptoms. Management problems are identified and corrective actions are systematically developed and implemented.
•     President’s annual diagnosis: This is the review of progress to develop activities which will continue to help each manager function at their full potential. The president’s audit focuses on numerical targets, but the major focus is on the process that underlies the results. The job of the president is to make sure that management in each sector of the organization is capable. The annual audit provides that information in summary and in detail.

Six Sigma

Six Sigma
There are those who will tell you that Six Sigma is radical and new. The fact is that Six Sigma (done properly) is a recognisable evolution of TQM. De Mast (2006) sees it as an on-going phase in the evolution of methods and approaches for quality and efficiency improvement. Six Sigma can be seen as the accumulation of principles and practices developed in management statistics and quality engineering, all of which matured significantly over the course of the Twentieth Century.
The Six Sigma approach was first developed in the late 1980s within a mass manufacturing environment in Motorola (Harry, 1998) as they struggled to meet demanding quality targets on complex manufactured products; and become widely known when GE adopted it in the mid-90s (Folaron and Morgan, 2003; Thawani, 2004) when, arguably, it evolved from being a  process  improvement  methodology  to  a  broader,  companywide  philosophy.  Both  companies  still  consider  Six  Sigma as the basis for their on-going strategic improvement approach. Since the 1980s Six Sigma has become one of the most popular improvement initiatives; widely implemented around the world in a wide range of sectors (by companies such as Boeing, DuPont, Toshiba, Seagate, Allied Signal, Kodak, Honeywell, Texas Instruments, Sony, Bombardier, Lockheed Martin) that all declared considerable financial savings (Harry, 1998; Antony and Banuelas, 2001; Kwak and Anbari, 2006).
Other benefits claimed for Six Sigma include increased stock price, improved processes and products quality, shorter cycle times, improved design and increased customer satisfaction (Lee, 2002; McAdam et al, 2005). Six Sigma has undergone a considerable evolution since the early manifestations (Folaron and Morgan, 2003; Abramowich, 2005). Initially it was a quality measurement approach based on statistical principles. Then it transformed to a disciplined processes improvement technique (based on reducing variation within the system with the help of a number of statistical tools).  For  example,  Snee  (1999)  defined  Six  Sigma  as  an  ‘approach  that  seeks  to  find  and  eliminate  causes  of  mistakes or  defects  in  business  processes  by  focusing  on  outputs  that  are  critical  importance  to  customers’.  The  definition  given in 1999 by Harry and Schroeder (1999) also defines Six Sigma as ‘a disciplined method of using extremely rigorous data gathering and statistical analysis to pinpoint sources of errors and ways of eliminating them’. In  its  current  incarnation  it  is  commonly  presented  as  ‘a  breakthrough  strategy’  and  even  holistic  quality  philosophy (Pande,  2002;  Eckes,  2001).  It  is  now  generally  accepted  that  Six  Sigma  is  applicable  to  various  environments  such  as service, transactions or software industry regardless the size of the business (Pande, 2002; Lee, 2002) and being adapted Six Sigma may lead to nearly perfect products and services. Moreover, Six Sigma is widening its areas of application very rapidly and there are examples of applying Six Sigma to predicting the probability of a company bankruptcy (Neagu and Hoerl, 2005) or finding opportunities for growth (Abramowich, 2005).
In  the  past  five  years,  hundreds  of  organizations  have  indicated  their  interest  in  making  Six  Sigma  their  management philosophy  of  choice.  While  many  of  the  businesses  attempting  to  implement  Six  Sigma   are  well  intentioned  and  want to implement  Six Sigma  properly just as General Electric did, there are also those impatient executives who now look on Six Sigma  in the same way as they look on downsizing. This quick-fix approach to  Six Sigma  is a sure path to the same short-term results that prevent long-term profitability.It  is  worth  noting  that  the  evolution  of  Six  Sigma  is  continuing  with,  for  example,  the  integration  of  Lean  Principles, development of a product/service variant (Design for Six Sigma) amongst others (De Mast, 2006). 

Mean Variance Efficiency

The Role of Mean-Variance Efficiency

We began the Chapter with an idealized picture of investors (including management) who are rational and risk-averse and formally analyses one course of action in relation to another. What concerns them is not only profitability but also the likelihood of it arising; a risk-return  trade-off with which they feel comfortable and that may also be unique.

Thus, in a sophisticated mixed market economy where ownership is divorced from control, it follows that the
objective of strategic financial management should be to implement optimum investment-financing decisions using risk-adjusted wealth maximizing criteria, which satisfy a multiplicity of shareholders (who may already hold a diverse portfolio of investments) by placing them all in an equal, optimum financial position.

No easy task!

But remember, we have not only assumed that investors are rational but that capital markets are also reasonably efficient at processing information. And this greatly simplifies matters for management. Because today’s price is  independent  of yesterday’s price, efficient markets have  no memory  and individual security price movements are  random. Moreover, investors who comprise the market are so large in number that no one individual has a comparative advantage. In the short run, “you win some, you lose some” but long term, investment is a  fair game  for all, what is termed a “martingale”. As a consequence, management can now afford to take a  linear  view of investor behavior (as new information replaces old information) and model its own plans accordingly.

 Like Fisher’s Separation Theorem, the concept of linearity offers management a lifeline because in efficient capital markets, rational investors (including management) can now assess anticipated investment returns (ri) by reference to their probability of occurrence, (pi) using classical statistical theory. What rational market participants require from companies is a diversified investment portfolio that delivers a maximum return at  minimum risk.

What management need to satisfy this objective are investment-financing strategies that maximize corporate wealth, validated by simple  linear  models that statistically quantify the market’s risk-return  trade-off .

If the returns from investments are assumed to be random, it follows that their  expected return (R) is the expected monetary value (EMV) of a symmetrical,  normal  distribution (the familiar “bell shaped curve” sketched overleaf). Risk is defined as the  variance  (or dispersion) of individual returns: the greater the variability, the greater the risk.

Incremental IRR (Internal Rate of Return)

The Incremental IRR

Despite their apparent wealth maximization defects, IRR project rankings that conflict with NPV
can be brought into line by a  supplementary  IRR procedure whereby management: 

Determine the incremental yield (IRR) from an  incremental investment,
which measures marginal profitability by subtracting one project’s cash
inflows and outflows from those of another to create a  sub-project 
(sometimes termed a  ghost or  shadow project).

To prove the point, let us incremental the data from Section 3.1.Two projects that not only
differ with respect to their cash flow patterns ( size  and  timing ) but also their investment cost.

Project  Year 0  Year 1  Year 2  Year 3  Year 4  Year 5  IRR(%) NPV
                                                                                   15%        (10%)  
1 less 2  (35)      (30)     -           20     40   50   11.1

You will recall that IRR maximization favored a higher  percentage return on the smaller more
liquid investment (Project1), whereas NPV maximization focused on higher money profits
overall (Project 2). Now see how the incremental IRR (15%) on the incremental investment
(Project 1 minus Project 2 = £35k) exceeds the discount rate (10%) so Project 1 is accepted.
Moreover, this corresponds to Equation (1) on single project acceptance. The incremental NPV is
positive (£11.1k) because its discount rate r < incremental IRR.

Debt Ratios Caluculation

Debt Ratios
        Debt ratios are calculated to assess that how much a firm is using financial leverage for profit maximization with the combination of total assets.
These also reflect that how much the firm has the ability to service debt to make the payments required on a scheduled basis over the life of debt.
In debt ratios, coverage ratios also measure the bank’s ability to pay certain fixed charges.
                                          Total Liabilities
Debt Ratio =                             
                                    Total Assets  
1. Time Interest Earned Ratio
        It is also called the Interest Coverage Ratio, measures the firm’s ability to make contractual interest payments. Greater the ratio means that firm is better position to make fulfill its interest obligations.
                                                 Earning Before Interest and Taxes
 Time interest Earned Ratio  =                                                     
                                                            Interest Amount
 Earning before income and taxes includes the total interest income and non-interest income, after deducting non-interest expense during the year(s). Interest amount includes interest payments made on deposits (current, saving, fixed) and investments.
2. Fixed Payment Coverage Ratio
        The fixed payment coverage ratio was used to measure the firm’s ability to meet all fixed-payment obligations, such as interest and principal, lease payments, and preferred stock dividends.
                         Earning before interest and taxes + Lease payments
 FPCR        =                                                                                     
                            Interest+ Lease Payment+ (Principal) x (1/1-T)
         T      = Tax rate applicable to bank income.
(1/1-T)      = The term included to adjust the after tax principal amount of borrowing and lease payments back to before tax equivalent.

Investment Risk and Return

Investment Risk and Return
Risk means uncertainty. In investment risk, when there is uncertainty attached with the outcomes of investment opportunity. In global markets there are lot of risk attached with the securities that can negatively affect the return of an investment opportunity.
There are basically two types of risks:
1. Systematic Risks    These risks occur inside the organization that can affect the profits of the organization. such as inefficiency of the management, labor unavailability or strikes. We say this risk as controllable because this can be controlled to some extent by the executives.
2. Unsystematic Risks    This type of risk exist outside the organization and are more worse than systematic risks. Such as political factors, competitors strategies, material unavailability, etc. This is also called uncontrollable because it cannot be controlled by the management of the firm.
The return on investment varies from company to company depending upon the nature of organizations and their basic objectives. If the organization is for charitable purposes it will require the non-profit return.
The return may in different forms like increase of sales volume, increase in the firm marketability, increase in customers loyalty. And also return may be positive or negative. This depends upon the risk associated with the investment opportunities.
Risk and return both go side by side in investment opportunities. The most spoken business slogan is "Higher the risk higher the return". Means investing in most risky portfolio (set of diversified investment opportunities) will yield the higher return as compared to the risk free assets. But in portfolio management when we combine different investment opportunities to composite the portfolio and we want higher return with minimum risk. For this purpose we add a risk free asset in our portfolio.

Capital Budgeting

Capital Budgeting
Capital budgeting is the process of evaluating and selecting long-term investments opportunities that are parallel with the firm's objectives. And to fulfill these objectives different investment opportunities are evaluated and then finally one is selected. And, firm generally made capital expenditure in earning assets that could increase their earning capacity.
Following are the key motives for capital expenditures:
1. Expansion    The most common motive is the expansion of firm's operations. And in this firms generally acquire fixed assets because only fixed assets can increase the earning capacity.
2. Replacements    When the machinery of the firm outdates then replacements decisions are made. Replacements are also made when the firm reaches maturity and its growth slows.
3. Renewal    This is the alternative of replacements. This involves rebuilding, overhauling or retrofitting an existing fixed asset. Basis difference is that in replacement we replace the whole asset but in renewal we only replace the a part of asset.
4. Other    If firm make expenditure other that above mentioned that it will fall in this category.
Steps in Capital Budgeting
Different authors present different approaches in capital budgeting process. But the basic logic is same:
1. Screening and Selection of Investments    Among different investment opportunities we generally evaluate and select the investment opportunity by using Capital Budgeting techniques (DCF and Non DCF).
2. Capital Budget Proposal    A budget is proposed in which it is discussed that what will our key expenditure? What will be the total cost of investment? When cash flows will occur?
3. Budget Approval and Authorization    The proposed budget is presented to the top management for approval and top management make authorization and gives the directions that from when these funds will be generated, some time internally and some time externally.
4. Implementation    Following the approval and authorization the expenditures are made and project is implemented.
5. Evaluation and control    Once the project is implemented the results are monitored and matched with the objectives of the firm.

Time Value of Money

Time Value of Money
Financial managers and investors are always confronted with the opportunities to earn positive rates of return on their funds. And we always know that in every single investment opportunity their are always number of cash flows (inflows or outflows). And these cash flows are either same or vary from time to time. We also know that every time there is the uncertainty in the outcomes of returns and inflation is increasing day by day. And it greatly affect the value of money. So, the sensitive financial managers and investors keep close eye on it.
In time value of money we use two inverse concepts:
1. Future Value
2. Present Value
Future value simply means that what will the future value of the present investment opportunity. For example, we keep $1000 in treasury and we forget. After some months when we find it and evaluate its worth we say that this is $1000. But actually when we use time value concept its worth has been decreased because if we had invested that $1000 in any investment opportunity we got some return and obviously, it will  be greater than $1000.
Present value simply means that what is the present value of the future cash flow from an investment opportunity. We generally find the present value of the future cash flow. Because, we know that dollar today is worth more than dollar tomorrow. The logical matter behind the present value is same as behind the future value.
Above mentioned both techniques are used in capital budgeting decisions. In which we evaluate different investment opportunities and made decisions on the basis of present and future values. But one thing should be clear that both present and future value concepts are used in Discounted Cash Flow (DCF) techniques.

DuPont System Of Analysis (EXTENDED)

DuPont System (Extended)
We use extended DuPont system because it provides the additional insights into the effect of financial leverage. The concept and use of the model is the same as the basic DuPont system except for a further breakdown of components.
Combining the Operating profit margin and total asset turnover;

  EBIT                  Net Sales                       EBIT
                X                              =                     
Net Sales           Total Assets                 Total Assets

To consider the negative effect of financial leverage, we deduct the interest expense;
  EBIT                           Interest                      EBT
                        _                              =                     
Total Assets               Total Assets               Total Assets

To find the positive effect of financial leverage, we will get;
   EBT                             Total Assets             EBT
                        X                              =                     
Total Assets               Common Equity           Common Equity

Finally to reach on ROE, we multiply the tax retention rate;
   EBT                                Income Tax              EBT
                       X   1-                        =                      
Common equity               EBT                       Common Equity

 

In summary, we use the following five components in extended DuPont system of analysis;
  EBIT       
1.                             =      Operating profit margin
T. Revenue        
 
T. Revenue
2.                            =      Total asset turnover
Total Assets
 
  Interest  
3.                            =      Interest expense rate
Total Assets
 
Total Assets
4.                            =      Financial leverage multiplier
Common Equity       


income Tax       
5.     1-                             =      Tax retention rate
            EBT      

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